On February 1st, Grubb & Ellis Healthcare REIT II triumphantly announced that it had met all of its minimums by raising a total of $20 million. This means that the newly minted Non-Traded REIT is free to release all investor funds from escrow and accept all subscribers as shareholders. Grubb & Ellis then announced plans - almost simultaneously - to acquire its first property: Highlands Ranch Medical Pavilion, an approximately 37,000-square-foot, multi-tenant medical office building in Denver. By way of contrast, Terreno Realty, another newly organized REIT, has now failed in all three of its attempts to go public via Goldman Sachs [update: TRNO is now public].

So what does Grubb & Ellis know about investment banking that Goldman Sachs does not? For starters, Grubb & Ellis hits 'em where they ain't. Grubb targets primarily retail investors, none of whom are likely to be as demanding as the institutions on Goldman's syndicate list. It's doubtful than many Grubb shareholders even bothered to read the offering documents, never mind know that Grubbs & Ellis just handed them a $4 million bill for helping launch the REIT. Indeed, Non-Traded REIT shareholders are a very tolerant bunch, mostly because they are anesthetized by shares valued at $10 no matter what the company earns, and a 6.5% dividend that somehow gets paid even thought the REIT has no assets and is losing money.

Nevertheless, it's hard to suspend the laws of profit and loss. According to the [url=http://www.faqs.org/sec-filings/091104/Grubb-and-Ellis-Healthcare-REIT-II-Inc_10-Q/]Grubb & Ellis Healthcare REIT II third quarter 10Q[/url], Grubb & Ellis Healthcare REIT II had no income or assets as of September 2009, yet it wracked up over $1.7 million in expenses. As owners, shareholders are ultimately on the hook for these expenses, and this means that after paying selling commissions of 7% and a dealer manager fee of 3%, plus the expenses incurred through September 2009, Grubb & Ellis investors had lost 18.5% of their investment just for the privilege of saying "I do".

Grubb & Ellis intends to raise $3 billion, but let's assume Grubb & Ellis suddenly runs into the same demanding customers that are Goldman Sachs's stock in trade. If no more money can be raised for whatever reason, this leaves the initial shareholders with only $16.3 million to buy income producing real estate. $16.3 million is not nearly enough to produce a safe, diversified portfolio, nor will it likely be enough to produce a reliable 6.5% dividend. It's difficult to imagine Warren Buffet (a prominent client of Goldman Sachs) accepting risks like this, never mind agreeing to "invest" 18.5% in fees and expenses.

But it gets much, much better. The prospectus also allows Grubb & Ellis to charge shareholders a 2.75% fee for each property it buys, and to be reimbursed for acquisition expenses, up to a combined total of 6%. Consequently, investors don't really have $16.3 million left over, because they still need to pay Grubb & Ellis another 6% to actually do something of value.

Using Highlands Ranch as an example, let's assume the acquisition price was $15 million, and that investors were held up for the full 6% acquisition fee monte. The result? An additional $900,000 of investor capital has gone up in smoke. Out of the original $20 million, this leaves investors with just $400,000 in cash and one $15 million property outside of Denver. For those of you keeping score at home, this means that as of February 1st, current investors have lost almost 25% of their money to fees and expenses, yet not one rent check has been collected and not one penny of income has been generated by the REIT.

Meanwhile, Highlands Ranch needs to generate $1.3 million in annual free cash to cover Grubb & Ellis's 6.5% dividend on the original $20 million. This is a virtual impossibility. $1.3 million per annum would equate to an approximate 10% cash on cash return from this acquisition, assuming no leverage. Given that the current market is not generating 10% returns, and that investors still owe Grubb & Ellis an asset management fee of .85% per annum, and that they are on the hook for all expenses, earning a 10% net cash on cash would be the equivalent of escaping from the Poseidon.

So how does Grubb & Ellis do it? It's simple: Grubb & Ellis just sells more Non-Traded REIT shares to new, still more naive shareholders. Then they take the money from these new shareholders and pay all the old shareholders. Impossible to believe? Maybe - but it's all perfectly legal and it's happening now (see [url=http://www.reitwrecks.com/forum/viewtopic.php?f=2&t=5]REISA Addresses Non-Traded REIT Ponzi Schemes[/url]). Is this really a safe place to put your money?

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